The Pros and Cons of Qualified Retirement Plans

You need to start thinking about saving for retirement as soon as you enter the workforce. Employers typically make this easy by offering a 401(k) plan, or a 403(b) plan in the case of tax-exempt organizations like schools and hospitals. 401(k) and 403(b) accounts are considered qualified plans and must meet standards set by the Employee Retirement Income Act (ERISA). They can be excellent tools for building your retirement income, but they also come with certain restrictions.

Below, we’ll look at some of the benefits and limitations of qualified retirement plans.

Saving for Retirement with a Qualified Plan

Qualified plans are tax-deferred. That means that any money you add to the account in a given year won’t count as taxable income, as long as you don’t exceed the maximum contribution defined by the IRS. You can continue growing money in this account without paying taxes on it until you start withdrawing.

Many employers offer matching qualified retirement plans to incentivize employees to stay with them. Some 401(k) plans allow employers to match up to 6% of an employee’s contributions. This essentially means employees are getting free (tax-deferred) money to use as income when they retire.

The most obvious benefit of a qualified retirement plan is that it provides you with a reliable source of income for your retirement. Rather than relying on Social Security and struggling to get by every month, you’ll be able to enjoy a comfortable retirement—as long as you have spent adequate time growing your wealth through your retirement plan.

Restrictions on Qualified Retirement Plans

The biggest thing you must keep in mind with a qualified retirement plan is that it isn’t tax-free. You’ll pay taxes every year that you draw an income from the plan, the same way that you pay taxes on your annual income now. Beyond that, there are several other restrictions on qualified retirement plans.

The IRS sets annual contribution limits for retirement plans. In 2018, the maximum employee contribution limit for a 401(k) is $18,500. If you add more than contribution limit set for the year, it will be taxed as income.

There are also age limitations for withdrawing money from a qualified retirement plan. If you withdraw money from the account before the minimum distribution age of 59 ½, you’ll have to pay a 10% early withdrawal penalty. If you do need to move money from a 401(k)--after switching jobs, for example-- it’s better to roll the money over to another qualified or non-qualified retirement plan than to withdraw it.

Finally, you must start withdrawing required minimum distributions from your qualified retirement plan when you reach the age of 70 ½. If you don’t withdraw the minimum required amount every calendar year, you’ll have to pay a 50% federal penalty on the difference between the minimum amount and what you actually took out.

What About Non-Qualified Plans?

There are many benefits to qualified retirement plans, but their restrictions make them relatively inflexible long-term investments. Fortunately, there’s a more flexible option that individuals can use to supplement their retirement savings: the non-qualified plan.

Employers sometimes offer non-qualified plans, such as split-dollar life insurance or executive bonus plans, to high-earning employees. There are no limits on contributions to these plans, and money in these plans can be tax-deferred if placed in an irrevocable trust.

Even if you’re not an executive, it’s possible to add money to a non-qualified retirement account with the assistance of Americans for Life Financial Services. We can help you roll over an old 401(k) into an IRA or low-risk alternative investments. Call us at (860) 222-0976 or email mike@americansforlife.com to learn more about our fund management services.